Summary, problems and prospects for development

A generalisable finding from this section of the report appears to be that public investment (in education, in the quality of infrastructure, and in market structures) is an important determinant of the capacity for rural growth.

Two stages in rural economic growth are discerned. In one, rural non-agricultural incomes are a refuge from poverty, and rural diversification a defensive strategy that implies a shift to low-return activities in order to preserve household income, generally without achieving local economic growth. This description applies to Armenia but also generally to most CIS and Balkan countries. Most Central European countries have entered the other, and subsequent, stage. Here rural manufacturing, trade, and services are a response to new market opportunities, generate higher returns than agricultural production, and signify genuine rural economic growth.

Although the rural non-agricultural sector in transition countries has been found to be substantial, the above observations on Armenia indicate that the significance, in economic terms, of the sector is not unambiguous. The non- farm rural economy is strongly agriculture-related, mainly through processing but also by providing inputs. The policy question is not what the trade-off between agricultural and non-agricultural employment and incomes is, but rather how enterprises in the non-agricultural part of agri- food sector can be supported. Second, rural non-farm enterprises vary greatly in size as measured in revenue levels. Polices designed to support them should be accordingly flexible.

This is further explored in our analysis of the survey data on non- farm enterprises in rural Armenia. The main findings may be summarised as follows:

• The majority of surveyed enterprises are specialised, profit-oriented businesses providing a full income to the entrepreneur and employees.

• The capacity for salaried employment is limited per enterprise to a few employees; but in many cases entrepreneurial income sustains people in and beyond the entrepreneur’s (owner/manager) household though unpaid labour

• There are very large variations in the financial features of enterprises, including cost, revenue, and profit levels

• There are strong links with the agricultural sector through food processing or trade in food products.

• Marketing channels are generally in the local economy and small-scale, with most firms in retail.

• Liquidity and capital constraints are general, and the most important constraint to enterprise expansion (or in some cases indeed operation), is access to credit.

• The role of public institutions in business support appears very limited, although there is much to be improved in factors that are usually in the domain of public action, such as legal safety and the quality of infrastructure.

The survey data are also used to undertake some basic explorations of the determinants of profit, employment, and incomes generated by the surveyed non- farm enterprises. Profit levels are satisfactorily explained by conventional inputs: labour, fixed capital, and inputs. Of these, employment is of special interest from a rural

development point of view. It appears that the size of the labour force, though modest in all cases, is linked to the level of fixed capital and access to credit. It is also negatively associated with the share of retail sales, and with capital input expenditures.

There appear to be important regional differences in the relationship between employment and income on the one hand, and businesses’ capital stock and levels of revenues and expenditure on the other. This confirms the theory that expansion of the rural non-farm economy is likely to have very different implications for rural emplo yment and rural incomes in different regions.

The most common forms of organisation of rural non- farm enterprises are limited liability companies and individual proprietorships, followed by co-operatives and partnerships. The most widespread activity is trade, followed by other production, processing and bakeries.

75 percent of non-farm enterprises were formed in the four-year period between 1997- 2000. Enterprises are very small, on average there are 5.2 standard full time employees per enterprise. According to the Act No. HO-121 adopted by the National Assembly on 5.12.2000, among the 45 surveyed enterprises 37 are classified as micro- and 8 are small enterprises.

The cost/benefit coefficient of non-farm enterprises depends on the type of activity and form of organisation. The riskiest activity appears to be food processing whilst running a bakery is the most stable. In terms of organisational form the cost/benefit coefficient is highest among individual proprietorships and limited liability companies, and lowest for JSC’s.

Credit is mainly provided to relatively large enterprises, since they have liquid collateral. Increasingly younger people with a high level of education are becoming non- farm enterprise owners. Those with a lower level of education prefer to do business as individual proprietors with a preference for trading activities. In enterprises managed by entrepreneurs/ owners having higher education the turnover per standard full- time employee is 2-3 times higher than in firms with less educated managers.

In terms of organisational form, LLC’s have the highest and JSC’s the lowest workforce productivity. When classified in terms of activity enterprises involved in ‘other industry’ has the highest and those providing public services the lowest productivity.

The majority of clients are domestic clients, within a 50 km distance. Only one enterprise sells 5 percent of its products abroad (CIS). Only one enterprise has suppliers from other countries (EU), which account for 26 percent of the firm’s procurement. There is also a long average distance from extension services (37.4 km), which may be important because of the “young” age of businesses, and the owner/ managers general lack of experience in doing business in a market economy.

The most important local factor hindering the activities of businesses is poor infrastructure (road, rail and telecommunications links), which was rated as

unsatisfactory by 55.8 percent of respondents. The level of legal protection is also very low and was rated as unsatisfactory by 67 percent of respondents.

Individual proprietorships and limited liability companies are optimistic about their short-term perspectives. The most promising activity is considered to be trade. About 75% of the surveyed enterprises want to expand their businesses, for which the shortage of capital and lack of access to it appear to be significant constraints on their development.

Credit repayment guarantees are very important in transition economies, where all activities have high risks. For this reason collateral plays a key role in credit provision. Collateral has two functions in transition economies: a) it is a guarantee for the creditor in case of insolvency on the part of the credit receiver; b) evaluates the capacity for repaying the credit and is an incentive for repaying the credit. Creditors try to overcome this problem by using the following substitutes for collateral: signing agreements, third party guarantee, belongings and equipment with a value equal to the amount of the credit, threat of being barred from future credit access/ applications and public sanctions.

Credit programmes without collateral requirements should be developed in Armenia in order to overcome the shortage of collateral. Credit clubs, already established in Armenia in some form, can play an important role in this regard. The Agricultural Co-operation Bank of Armenia (ACBA) has established rural co-operation clubs, which have a collective responsibility for repaying credit. The club selects those members, who will receive credits and the amounts of credits, and if any member does not repay the debt, the entire club will lose the right to receive credit in the future. The UMCOR Armenia office also has similar programmes. Currently, the National Assembly is in the process of adopting the Credit Club Act.